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Watch for more mergers and acquisitions among companies that find and extract oil and gas.

As the price of West Texas Intermediate crude oil plunged more than 30% from its peak last October, stocks in the energy sector also got hit hard. Shares of oil and gas exploration and production companies within the S&P 500 (.SPX) have dropped 18.5% over the past three months, while the broader index fell 5.5%.

Many smaller E&P companies, focused on a single geological basin, are trading at substantial discounts to their net asset values, Morgan Stanley analyst Devin McDermott wrote in a Monday research note. The decline has created great opportunities for interested buyers to step in, he said.

"There is certainly high-quality assets in the marketplace and buyers ready to acquire," a note from the energy-data analytics company Drillinginfo said last week. Watch for more mergers and acquisitions among companies that find and extract oil and gas.

As the price of West Texas Intermediate crude oil plunged more than 30% from its peak last October, stocks in the energy sector also got hit hard. Shares of oil and gas exploration and production companies within the S&P 500 have dropped 18.5% over the past three months, while the broader index fell 5.5%.

Many smaller E&P companies, focused on a single geological basin, are trading at substantial discounts to their net asset values, Morgan Stanley analyst Devin McDermott wrote in a Monday research note. The decline has created great opportunities for interested buyers to step in, he said.

"There is certainly high-quality assets in the marketplace and buyers ready to acquire," a note from the energy-data analytics company Drillinginfo said last week.

Lower valuations are especially important now because oil prices have fallen, making it harder for companies to earn money. Companies in exploration and production—a high-risk, high-reward business—have become more sensitive to levels of free cash flow and try to spend more frugally.

"Investors continue to demand that companies deliver a clear line-of-sight to positive free cash flow," wrote Drillinginfo M&A analyst Andrew Dittmar. "Wall Street no longer supports growth for growth sakes and is ready to punish buyers who do deals without a clear profit strategy."

Morgan Stanley's McDermott noted that although buyers in deals focused on shale resources underperformed their peers by an average of 14% in the 30 days after the announcement of a transaction, companies that have shown "sound industrial logic and strategic rationale" for their purchases ultimately reversed the underperformance in the following months.

Consolidation is attractive for E&P companies because it can increase the scale of operations, a competitive advantage that can lead to higher returns. Merging companies with adjacent fields can yield savings from shared infrastructure, optimizing their supply chains, and reducing administrative expenses, writes McDermott. Larger players may have better bargaining power with suppliers, he says.

Even before the oil price began to slump last fall, shale energy assets had proven appealing to Big Oil. Exxon Mobil (XOM) bought the Bass family's assets in Texas' Permian Basin in 2017, while BP (BP) recently acquired shale assets from BHP Group (BHP) in last summer, noted McDermott.

The attractive valuations might even bring about resurgent interest in the private-equity market. "Many companies are not realizing their full value in the public markets and could potentially find value in being taken private," writes McDermott.

M&A among E&P companies picked up in 2018. Companies spent a total of $84 billion on deals last year, the highest level since late 2014, according to data from Drillinginfo. As of Dec. 31 2018, about $39 billion worth of E&P oil and gas assets were being offered for sale, according to its estimates.

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